After the PNB fiasco, what to do with banking shares now

THERE is so much news and relentless social media coverage around the Rs 11,300 crore fraud at Punjab National Bank. With an ability to tap and broadcast through instant messaging, everyone has become an expert in the banking sector. It can get overwhelming and confusing. As an investor, you may wonder whether you should be a seller in this panic or looking for striking some good bargains at a low price. It is important to reiterate that share prices today are a reflection of tomorrow’s profit. This applies to every sector including banking.

The stock market reaction to Rs 11,300 crore fraud at Punjab National Bank has resulted in share prices tumbling. Over the past month, PNB shares have lost a third of their value falling 33 per cent while overall Nifty Bank index fell 7.2 per cent. Other key public sector banks like SBI and Bank of Baroda shed 12 per cent value during the same period. Private sector banks like HDFC Bank fell only 4 per cent while Kotak Mahindra Bank fell only 1.1 per cent. If you are invested in banking shares or holding sectoral mutual funds that own them, you may want to take a look at some recent developments. There is a lot to read in the price movement.

What next for PNB?

Stock markets hate uncertainty. While banking frauds are not new to public sector banks, most investors are not able to ascertain the impact of this situation on the future profits of PNB.Hence, the immediate reaction is to sell these shares and invest in other banks or other sectors. When a bank loan goes into default like in this case, the bank has to pay for it from profits accrued or by selling other assets or raising fresh capital. In this case, the quantum of final devolvement and funded exposure has not yet been ascertained. Whenever the exact liability arising out of the outstanding letters of understanding or LOUs worth Rs 11,300 crore is clear, the banks profit would take a hit. Analysts also think the bank may need additional capital. The bank’s management told analysts in a conference call that it has adequate resources to meet any challenges.

“We forecast a loss of Rs 7,600 crore in 2017-18 (loss of Rs 8,760 crore in Q4), a capital infusion of approximately Rs 5,500 crore,” said an analyst at foreign brokerage Jefferies. Similar estimates have been put out by an analyst at Nomura, a Japanese bank. The above steps mean going forward, the book value per share of the bank is expected to shrink. In the banking sector, a stock is cheap if it has a low price-book value ratio. It is expensive if it is high. If investors know that the book value of a bank would shrink going forward, they would seek to adjust the share price accordingly. On an average, public sector bank shares have traded around one time the book value. The sharp fall means PNB shares are trading at way below that average. There may not be a dramatic fall in the share price if losses are limited to as estimated by analysts.

Other banks

Shares of SBI, Bank of Baroda and other PSU banks also shed value along with PNB. Now, while they are not directly affected by this scam, there are other defaults to deal with. A Right to Information petition filed by news agency Reuters was reported to have revealed 8,670 frauds worth over Rs 61,260 crore in five years to March 2017. These are borrowers willingly defaulting on loans. It is worth noting that public sector banks have enjoyed the government support.

In January 2018, the government announced injecting Rs 88,139 crore in 20 public sector banks. The government is also strengthening the mechanism for recovery of non-performing loans that run into over Rs 7,30,000 crore for public sector banks. This is hurting their ability to lend more and earn more income. However, with recent measures, public sector banks could potentially bring down the quantum of NPAs. A loan is categorized as an NPA if a borrower fails to pay up interest for more than 90 days or do not pay at all. The bank earns an interest income on lending activities and needs borrowers to pay interest regularly. There is some good news for PNB on this front.

The interest shown by bidders in assets of Bhushan Steel and Power and Bhushan Steel (two separate entities) is expected to benefit PNB. The bank is estimated to have given close to Rs 10,000 crore worth of loans to the two entities. Any settlement on this account would free up the capital of the bank for tackling the current crisis and any new lending. This is part of the settlement being hammered out by the National Company Law Tribunal 1.

What lies ahead

Outside the present crisis faced by the banking industry due to non-performing assets or frauds, there is a lot going for them in the future. The effort to spread financial services to places where it did not exist before indicates that the potential for the banking sector to grow is immense.

The demand for banking services in rural India is set to rise and expand further in urban areas thanks to a rapid evolution in technology. Mobile banking, personalised banking, rural banking are buzzwords today. The stock market has put a very high value on private- sector banks like HDFC Bank, Kotak Mahindra Bank with a price-to-book ratio of four or five in comparison to one for PSU banks. Even non-banking finance companies like Bajaj Finance or HDFC enjoy a better market value than public-sector companies. This is reflected in almost limited impact on these companies when shares of PSU banks fell. The message from the market is that the future for financial services is bright. But the diverse price trend in PSU banks and others indicates that the market does not think everyone can capitalise on it.

(The writer is Publisher and Founder at Simplus Information Services Pvt Ltd)